Paushak: Has The Stock Gotten Way Too Ahead Of Itself?

Paushak is India’s largest phosgene-based specialty chemical manufacturer. It belongs to the storied Alembic Group of Companies which set up one of the first pharmaceutical plants in India. Paushak enjoys an unblemished track record of over 35 years and has established itself as a market leader across much of its product portfolio.

A 10-Year Revenue CAGR of 19% and 10 -Year Profit CAGR of 31% have led to handsome returns for investors, a 10-Year Stock Return CAGR of 60%!

Paushak’s Business Model:

Paushak’s business model has been relatively resilient due to the hazardous nature of Phosgene Chemistry, and the subsequent government regulations that act as entry barriers. The company supplies phosgene-based derivatives (intermediates) to the Pharmaceutical, Agrochemical, and Performance Chemical industries.

Let us quickly understand what Phosgene is and why it enjoys strict regulation.

What is Phosgene?

The toxicity as well as the relative ease with which it can be produced have led to a scarcity in the manufacturing permits that are issued. Hence, this stringent government regulation deters competition from entering this segment. Existing players too face an arduous process in procuring the required permits for expanding manufacturing facilities.

Paushak’s business strategy over the past few years can be summed up simply into three core areas:

Paushak’s Business Segments:

The company has a vast plethora of products in their portfolio list; however, they are not forthcoming about which products constitute their core!

The Contract Manufacturing segment has only recently started seeing interest. The company is in talks with one global agrochemical major (there have been no updates on the progress yet).

End User Industries Served by Paushak:

Competitive Advantages & Economic Moats Enjoyed by Paushak:

Risks Faced by Paushak:

Opportunities:

Financials:

Paushak is a debt-free company (has been near debt-free for the past 8 years) and expects to continue this trend.

**Pre Tax ROCE, After Tax ROIC

Valuation:

The key valuation driver for Paushak is the new capacity coming online. Unfortunately, we do not have any data regarding the revenue potential. In my valuation, I decided to use a Fixed Asset Turnover of 3.5 which is slightly below the 8 year average of 3.94. This leads me towards a 10 Year Revenue CAGR of 16% (I feel that I am being quite optimistic in this scenario).

I believe that operating margins above 30% are not sustainable in the future. I have modeled margins to remain rangebound between 21% and 26%, with Terminal Year stable margins at 22%.

Cost of Capital (Terminal Year) stands at 8.81% with an ROIC of 10.81%.

My estimates lead to a valuation of INR 2176.95 to INR 2436.79 per share, well below the current market price of INR 7971.65

Conclusion:

Paushak has generated tremendous wealth for its shareholders over the past decade surging from a high of INR 122.7 in 2011 to a high of INR 9479 in 2021 (as of today).

Over the course of a year, the stock has skyrocketed from a low of INR 1301 to a high of INR 9479, triggered by the approval for tripling of capacity along with a relatively well-moated business.

My biggest concern surrounding my valuation would be the lack of data about: Revenue Potential from New Capacities, Timelines, and Key Products. The lack of information and the ensuing uncertainty is a key risk when investing in smaller companies, justifying an explicit application of Margin of Safety.

To recapitulate, Paushak does seem significantly overvalued, with the ‘overvalued’ nature being largely contingent on the capacity expansion coming to fruition!  

%d bloggers like this: